macroeconomics & the global economy ace institute of management session 1
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Macroeconomics & The global Economy Ace Institute of Management Session 1. Instructor Sandeep Basnyat [email protected] 9841 892281. Objectives. To acquaint students with basic knowledge of macroeconomic theories - PowerPoint PPT PresentationTRANSCRIPT
Macroeconomics & The global Economy
Ace Institute of Management
Session 1
InstructorSandeep Basnyat
[email protected] 892281
ObjectivesObjectives
• To acquaint students with basic knowledge of macroeconomic theories
• Define, explain and analyze macroeconomic terms, theories and indicators in general
• Apply learning in decision making processes and solve real world issues
• Use and explain the macroeconomic and developmental problems in a country
Evaluation CriteriaEvaluation Criteria
• Class Participation 5%• Group Presentation 10% (5 Groups)• Midterm exams 15%• Term exam 40% (End Term)• Class Tests 10% (2 Tests)• Assignments 10% (1 Assignment)• Group Term Paper 10% (Submit at end)
Case study presentationsCase study presentations• Case study oriented classes• Possibility of external evaluator• Evaluation Criteria: (10 x 3 = 30 marks)
– Did the presentation reflect a team work among its members?
– Were the students prepared for the presentation?– Did the students look confident while deliberating?
(including eye contact & voice clarity)
Case study presentationsCase study presentations• Case Study Presentation Schedule
– Group1 Session 3– Group2 Session 5– Group 3 Session 6– Group 4 Session 9– Group 5 Session 10
Class tests, Assignment & Term Class tests, Assignment & Term paperpaper
• Class Test 1: Session 4• Class Test 2: Session 11• Assignment: Session 9• Term Paper:
– Preliminary Selection of Topic for term paper Session 3
– Development of Research idea on term paper Session 5
– Submission and Approval of the Topic with plan Session 7
– Submission of term paper Session 12
What you studied in Microeconomics..
• Basic demand and supply functions of individuals and markets
• Profit maximizations of individual firms in different markets
• Consumers and Producers welfare theories• Cost and benefits of firms in different markets.• And so on…• But NOW ….
Introduction to Macroeconomics
• Why does the cost of living keep rising?• Why are millions of people unemployed,
even when the economy is booming?• What causes recessions?
Can the government do anything to combat recessions? Should it?
Macroeconomics, the study of the economy as a whole, addresses many topical issues:
• What is the government budget deficit? How does it affect the economy?
• Why does Nepal have such a huge trade deficit? • Why are so many countries poor?
What policies might help them grow out of poverty?
Macroeconomics, the study of the economy as a whole, addresses many topical issues:
Introduction to Macroeconomics
And our analysis look...
0
10,000
20,000
30,000
40,000
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
U.S. Real GDP per capita (2000 dollars)
Great Depression
World War II
First oil price shock
Second oil price shock
long-run upward trend…
9/11/2001
U.S. inflation rate(% per year)
-15
-10
-5
0
5
10
15
20
25
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
U.S. unemployment rate(% of labor force)
0
5
10
15
20
25
30
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
Why learn macroeconomics?1. The macroeconomy affects society’s well-being.
Each one-point increase in the unemployment rate is associated with:
920 more suicides 650 more homicides 4000 more people admitted to state mental institutions 3300 more people sent to state prisons 37,000 more deaths increases in domestic violence and homelessness
Each one-point increase in the unemployment rate is associated with:
920 more suicides 650 more homicides 4000 more people admitted to state mental institutions 3300 more people sent to state prisons 37,000 more deaths increases in domestic violence and homelessness
Why learn macroeconomics?2. The macroeconomy affects your well-being.
-3
-2
-1
0
1
2
3
4
5
1965 1970 1975 1980 1985 1990 1995 2000 2005
-7
-5
-3
-1
1
3
5
unemployment rate inflation-adjusted mean wage (right scale)
chan
ge fr
om 1
2 m
os e
arlie
r
perc
ent c
hang
e fr
om 1
2 m
os e
arlie
rIn most years, wage growth falls when unemployment is rising. In most years, wage growth falls when unemployment is rising.
Introduction to MacroeconomicsIntroduction to Macroeconomics Macroeconomics: •Deals with the economy as a whole.
Study of the economy as a whole. Its goal is to explain the economic changes that
affect many households, firms, and markets at once.
1.1. Theory as a Model: Theory as a Model: Used to describe the real world eliminating unnecessary details
HOW DO MACROECONOMISTS THINK?HOW DO MACROECONOMISTS THINK?
A road map A model of human anatomy
The model teeth
Don’t forget to floss!
Macroeconomic models : Symbols and Equations
Two important variables in a models: Exogenous variables; and Endogenous variables.
• Exogenous (Independent) variables : that a model takes as given.
• Endogenous (dependent) variables : which the model tries to explain. (What happens to..??)
HOW DO MACROECONOMISTS THINK?HOW DO MACROECONOMISTS THINK?
• Assume the following two relationships for CD market:QQdd = D(P,Y) …………………(i) = D(P,Y) …………………(i)QQss = S(P,P = S(P,Pmm) …………………(ii)) …………………(ii)
Equation (i): shows that Quantity of the CD demanded is the function of the Price of the CD and Income level of the consumer or the aggregate income of the economy.
Equation (ii): shows that Quantity of the CD supplied is the function of the Price of the CD and Input price of the materials.
• The equilibrium in the CD market is given by:
QQdd = Q = Qss
THE MODEL OF SUPPLY AND DEMANDTHE MODEL OF SUPPLY AND DEMAND
Price
Demand, QQdd
QQ*
PP
Supply, QQss
QuantityQuantity
*
THE MODEL OF SUPPLY AND DEMANDTHE MODEL OF SUPPLY AND DEMAND
Price
Demand
QQ*
PP
Supply
QuantityQuantity
*
Exogenous Variables: Exogenous Variables: Aggregate Income, andPrice of the materials(taken as given)
Endogenous Variables:Endogenous Variables:Price of the CD, andEquilibrium quantity of CD
The model explains what happens to Endogenous variables (Price and Equilibrium Quantity of CD sold) when one of the
Exogenous variables (Aggregate Income and Price of the materials ) changes.
THE MODEL OF SUPPLY AND DEMANDTHE MODEL OF SUPPLY AND DEMAND
SHIFTS IN DEMAND
PP
DD
SS
DD'' SHIFTS IN SUPPLY
PP
DD
SS
SS''
EXAMPLE: CHANGES IN EXOGENOUS VARIABLESEXAMPLE: CHANGES IN EXOGENOUS VARIABLES
• General Assumption: Market equilibrium of supply and demand, (market clearing process).
• Markets clearing continuously, is unrealistic. • Need prices to adjust instantly to changes in supply and
demand. But, prices and wages often adjust slowly.
• Although market clearing models assume that wages and prices are flexible, in actuality, some wages and prices are sticky. But they do depict the equilibrium toward which the economy gravitates.
• Short term analysis vs Long term analysis for Price Sticky vs Price Flexibility
PRICES: FLEXIBLE VS. STICKYPRICES: FLEXIBLE VS. STICKY
Three statistics that economists and policymakers use:
Gross Domestic Product (GDP) is the dollar value of all final goods and services produced within an economy in a given period of time.
The consumer price index (CPI) measures the level of prices.
The unemployment rate tells us the fraction of workers who are unemployed.
GDP, CPI AND UNEMPLOYMENTGDP, CPI AND UNEMPLOYMENT
Two ways of viewing GDP
Total income of everyone in the economy
Total expenditure on the economy’s output of goods and services
Households Firms
Income $
Labor
Goods/ Services
Expenditure $
For the economy as a whole, income must equal expenditure. GDP measures the flow of dollars in the economy.
Gross Domestic Product (GDP)
In general, to compute the total value of different goods and services, the national income accounts use market prices. Thus, if
$0.50 $1.00
GDP = (Price of apples Quantity of apples) + (Price of oranges Quantity of oranges)
= ($0.50 4) + ($1.00 3)GDP = $5.00
Governmentpurchases of goods
and services
Governmentpurchases of goods
and services
Y = C + I + G + NXY = C + I + G + NXY = C + I + G + NXY = C + I + G + NX
Total demandfor domestic output (GDP)
Total demandfor domestic output (GDP)
Consumptionspending byhouseholds
Consumptionspending byhouseholds
Investmentspending by
businesses andhouseholds
Investmentspending by
businesses andhouseholds
Net exportsor net foreign
demand
Net exportsor net foreign
demand
This is the called the national income accounts identity.
Calculating GDPCalculating GDPComponents of U.S. GDP, 2004: The Expenditure Approach
BILLIONS OFDOLLARS
PERCENTAGEOF GDP
Personal consumption expenditures (C) 8,214.3 70.0Durable goods 987.8 8.4Nondurable goods 2,368.3 20.2Services 4,858.2 41.4
Gross private domestic investment (l) 1,928.1 16.4Nonresidential 1,198.8 10.2Residential 673.8 5.7Change in business inventories 55.4 0.5
Government consumption and gross investment (G)
2,215.9 18.9
Federal 827.6 7.1State and local 1,388.3 11.8
Net exports (EX – IM) 624.0 5.3Exports (EX) 1,173.8 10.0Imports (IM) 1,797.8 15.3
Gross domestic product (GDP) 11,734.3 100.0Note: Numbers may not add exactly because of rounding.Source: U.S. Department of Commerce, Bureau of Economic Analysis.
World Top 10 GDP in Millions of US Dollars in Market Price (Source: IMF2008/2009)
12. India - 1,235,975 109. Nepal - 12,615 160. Maldives- 1,357162. Bhutan - 1,269 181. Kiribati - 130
1) Used goods Used goods are not included in the calculation of GDP.2) The treatment of inventories The treatment of inventories depends on if the goods are stored or if they spoil. • If the goods are stored, their value is included in GDP.• If they spoil, GDP remains unchanged. • When the goods are finally sold out of inventory, they are considered used goods (and are not counted).
3) Some goods are not sold in the marketplace and therefore don’t have market prices. We must use their imputed value their imputed value as an estimate of their value. For example, home ownership and government services.
4) Intermediate goods Intermediate goods are not counted in GDP– only the value of final goods. Reason: the value of intermediate goods is already included in the market price. Value added of a firm equals the value of the firm’s output less the value of the intermediate goods the firm purchases.
Measuring GDP by the Value Added MethodMeasuring GDP by the Value Added Method
FIRM VALUE OF PRODUCT VALUE ADDED
Cotton Farmer Value of raw cotton = $1.00 Value added by cotton farmer = $1.00
Textile Mill Value of raw cotton woven into cotton fabric = $3.00
Value added by cotton textile mill = ($3.00 – $1.00)
= $2.00
Shirt Company Value of cotton fabric made into a shirt = $15.00
Value added by shirt manufacturer = ($15.00 –$3.00)
= $12.00
L.L. Bean Value of shirt for sale on L.L. Bean’s Web site = $35.00
Value added by L.L. Bean = ($35.00 – $15.00)
= $20.00
Total Value Added = $35.00
Exercise: (Problem 2, p. 40)
– A farmer grows a bushel of wheat and sells it to a miller for $1.00.
– The miller turns the wheat into flour and sells it to a baker for $3.00.
– The baker uses the flour to make a loaf of bread and sells it to an engineer for $6.00.
– The engineer eats the bread.
Compute & compare value added at each stage of production
and GDP
Other Exclusions from Expenditures
• Expenditure on purchase of goods and services during specified time period.– Previous expenditure reflects the change in ownership only.
• Avoid “neither good nor a service”– Does not reflect production such as bonds/ stocks
• Avoid expenditure by governments for which it does not receive a good or service in return– Eg.: Transfer payments such as Social security,,
unemployment compensation etc.
Measuring GDP from Income sideMeasuring GDP from Income side
• Sum of income of all factors of production gives the GDP from income side
• GDP = Rent + Wages + Interest + Profits
Calculating GDPCalculating GDPU.S. National Income, 1980 (Shapiro: Table 2-1, Pg.27; Adjusted)
BILLIONS OFDOLLARS
Gross Domestic Products (GDP) 2341.3
Compensation of employees 1804.4Proprietors’ income 130.6Corporate profits 183.8Net interest 190.6Rental income
Transfer payments to households if any.
31.9
Compensation of employees includes wages, salaries, and various supplements—employer contributions to social insurance and pension funds, for example—paid to households by firms and by the government.Proprietors’ income The income of non-corporate businesses such as small farms, shops.Rental income The income received by property owners in the form of rent.
Calculating GDPCalculating GDP
Corporate profits The income of corporate businesses.Net interest The interest received by the businesses minus interest they pay plus interests earned from the foreigners.
Remember: Gross Domestic Product (GDP)Remember: Gross Domestic Product (GDP)• Gross domestic product (GDP) is a measure of the
income and expenditures of an economy which includes all items produced in the economy and sold legally in markets.
But:– It excludes items produced and sold illicitly, such as illegal drugs.
Other Measures of incomeOther Measures of income
• Gross National Product (GNP)• Net National Product (NNP)• National Income (NI)• Personal Income (PI)• Personal Disposable Income (DI)
National Income Accounting National Income Accounting contd..contd..
• GDP + NFI from Abroad = GNP GNP is the monetary value of final goods and services produced by the nationals (income earned by the nationals on foreign countries minus income earned by foreigners at home)
• GNP – Depreciation (Capital Consumption) = NNPDepreciation is the net capital consumption during the accounting year
• NNP – Indirect Business Tax = NI (National Income)
National Income Accounting National Income Accounting contd..contd..
• NI – Social contributions – net interests paid by individuals – corporate profit tax –undistributed corporate profit + Dividends + Govt. & business transfers to individuals + Net interest paid to individual = PI (Personal Income)
• PI – Personal tax and non-tax payments (such as parking tickets) = DI (Disposable Income)Disposable income is the final income that a consumer spends on the purchase of goods and services
• DI – Saving – Personal Interest Payment – Household Transfer Payment = Personal Consumption Expenditure
GDP, GNP, NNP and National Income, 1980 (adjusted from Income Method)
DOLLARS(BILLIONS)
GDP at factor cost 2341.3Plus: Receipts of factor income from the rest of the world + 415.4Less: Payments of factor income to the rest of the world 127.9
Equals: GNP at factor cost 2628.8Less: Depreciation or capital consumption 287.5
Equals: Net national product (NNP) 2341.3Less: Statistical discrepancy 219.9
Equals: National income (NI) at factor cost 2121.4
Calculating other measures of Calculating other measures of IncomeIncome
National Income, Personal Income, Disposable Personal Income, and Personal Saving, 1980 (adjusted)
DOLLARS(BILLIONS)
National income 10,275.9Less corporate taxes Plus transfer payments 39.6
Equals: Personal income 2161.0Less: Personal income taxes 338.7
Equals: Disposable personal income 1822.2Less: Personal saving 103.6Less: Personal interest payments 46.5Less: Transfer payments made by households 1.1
Equals: Personal Consumption Expenditure 1671.1
Calculating other measures of Calculating other measures of IncomeIncome
Real vs. nominal GDP
• GDP is the value of all final goods and services produced.
• Nominal GDP measures these values using current prices.
• Real GDP measure these values using the prices of a base year.
Practice problem, part 1
• Compute nominal GDP in each year.
• Compute real GDP in each year using 2006 as the base year.
2006 2007 2008
P Q P Q P Q
good A $30 900 $31 1,000 $36 1,050
good B $100 192 $102 200 $100 205
Answers to practice problem, part 1
nominal GDP multiply Ps & Qs from same year
2006: $46,200 = $30 900 + $100 192
2007: $51,400 2008: $58,300
real GDP multiply each year’s Qs by 2006 Ps
2006: $46,2002007: $50,000 2008: $52,000 = $30 1050 + $100 205
Real GDP controls for inflation
Changes in nominal GDP can be due to:– changes in prices. – changes in quantities of output produced.
Changes in real GDP can only be due to changes in quantities,because real GDP is constructed using constant base-year prices.
U.S. Nominal and Real GDP, 1950–2006
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
1950 1960 1970 1980 1990 2000
(bil
lio
ns)
Nominal GDP
Real GDP(in 2000 dollars)
GDP Deflator
• The inflation rate is the percentage increase in the overall level of prices.
• One measure of the price level is the GDP deflator, defined as
Nominal GDP
GDP deflator = 100Real GDP
Practice problem, part 2
• Use your previous answers to compute the GDP deflator in each year.
• Use GDP deflator to compute the inflation rate from 2006 to 2007, and from 2007 to 2008.
Nom. GDP Real GDPGDP
deflatorInflation
rate
2006 $46,200 $46,200 n.a.
2007 51,400 50,000
2008 58,300 52,000
Answers to practice problem, part 2
Nominal GDP
Real GDPGDP
deflatorInflation
rate
2006 $46,200 $46,200 100.0 n.a.
2007 51,400 50,000 102.8 2.8%
2008 58,300 52,000 112.1 9.3%
Chain-Weighted Real GDP• Over time, relative prices change, so the base
year should be updated periodically.• In essence, chain-weighted real GDP
updates the base year every year, so it is more accurate than constant-price GDP.
• But we usually use constant-price real GDP, because: – the two measures are highly correlated.– constant-price real GDP is easier to compute.
Exercise 1: For your understanding• Make a note of:
– Real and Nominal GDPs of some of the important countries and compare
– Prepare a list of top 10 countries with their Real GDP growth rate and PPP growth rate.
Consumer Price Index (CPI)• A measure of the overall level of prices • Uses:
– tracks changes in the typical household’s cost of living
– Adjusts for inflation
– allows comparisons of dollar amounts over time
How to compute CPI
1. Survey consumers to determine composition of the typical consumer’s “basket” of goods.
2. Every month, collect data on prices of all items in the basket; compute cost of basket
3. CPI in any month equals
Cost of basket in that month
Cost of basket in base period100
Exercise: Compute the CPI
Basket contains 20 pizzas and 10 compact discs.
prices:pizza CDs
2002 $10 $152003 $11 $152004 $12 $162005 $13 $15
For each year, compute the cost of the basket in
each year the CPI (use 2002 as the
base year) the inflation rate from
the preceding year
Cost of Inflationbasket CPI rate
2002 $350 100.0 n.a.2003 370 105.7 5.7%2004 400 114.3 8.6%2005 410 117.1 2.8%
Answers:
The composition of the CPI’s “basket”
15.1%
42.4%
3.8%
17.4%6.2%
5.6%
3.0%
3.1%
3.5%
Food and bev.
Housing
Apparel
Transportation
Medical care
Recreation
Education
Communication
Other goodsand services
Reasons why the CPI may overstate inflation
• Substitution bias: The CPI uses fixed weights, so it cannot reflect consumers’ ability to substitute toward goods whose relative prices have fallen.
• Introduction of new goods: The introduction of new goods makes consumers better off and, in effect, increases the real value of the dollar. But it does not reduce the CPI, because the CPI uses fixed weights.
• Unmeasured changes in quality: Quality improvements increase the value of the dollar, but are often not fully measured.
CPI vs. GDP Deflatorprices of capital goods– included in GDP deflator (if produced domestically)– excluded from CPI
prices of imported consumer goods– included in CPI– excluded from GDP deflator
the basket of goods– CPI: fixed– GDP deflator: changes every year
Categories of the population• employed
working at a paid job • unemployed
not employed but looking for a job • labor force
the amount of labor available for producing goods and services; all employed plus unemployed persons
• not in the labor force not employed, not looking for work
Two important labor force concepts
• unemployment rate percentage of the labor force that is unemployed
• labor force participation rate the fraction of the adult population that “participates” in the labor force
Exercise 1: For your understanding• Make a note of:
– Real and Nominal GDPs of some of the important countries and compare
– Prepare a list of top 10 countries with their Real GDP growth rate and PPP growth rate.
– Find CPI Index of various some important countries and check the inflation rates.
Numerical Example 1
Employee compensation (EC) 3,244Rental income (RI) 16Net interest (NETI) 467Capital consumption (CC) 567Corporate taxes (CT) 145Social Security taxes (SST) 440
Personal taxes (PT) 700Undistributed corporate profits (UCP) 37Corporate profits (CP) 297Proprietor's income (PROI) 402Indirect business taxes (IBT) 470Transfer payments (TP) 660 Population (POP) 250 (billions of
people)
Calculate GDP, GNP, NI and DI
GDP = Employee compensation + Rental income + Net interest + Corporate profits + Proprietor's income = Billion $4426
GNP = GDP + NIF = 4426 + 0 = Billion $4426
NI = NNP – Indirect Business Taxes= GNP – Capital Consumption - Indirect Business Taxes = Billion $3389
DI = PI – Personal tax and non-tax payments = NI – Social contributions– corporate profit tax –undistributed corporate profit + Govt. & business transfers to individuals – Personal tax and non-tax payments= Billion $ 2727
For Further practice:Macroeconomics by N. G. Mankiw, 6th edition. Q.N. 2, 5, 6 and 7.
Solution to Numerical Example 1
Numerical Questions and Solutions for Practice
1) Abby consumes only apples. In year 1, red apples 1) Abby consumes only apples. In year 1, red apples cost 1$ each, green apples cost 2$ each, and Abby buys cost 1$ each, green apples cost 2$ each, and Abby buys 10 red apples. In year 2, red apples cost 2$ each, green 10 red apples. In year 2, red apples cost 2$ each, green apples cost 1$ each, and Abby buys 10 green apples. apples cost 1$ each, and Abby buys 10 green apples. Compute a consumer Price index (CPI) for apples for Compute a consumer Price index (CPI) for apples for each year. Assume that year 1 is the base year in which each year. Assume that year 1 is the base year in which the consumer basket isthe consumer basket isfixed. fixed. (Mankiw. Pg. 41. Q. 7)(Mankiw. Pg. 41. Q. 7)
a.
Solution for Q. 1
CPI in Year 1 =Price in Current YearPrice in Base Year
--------------------------------------
---------------------------------------------------------------------
(PRed1 x QRed1) + (PGreen1 x QGreen1)(PRed1 x QRed1) + (PGreen1 x QGreen1) = 1
CPI in Year 2 =Price in Current YearPrice in Base Year
--------------------------------------
---------------------------------------------------------------------
(PRed2 x QRed1) + (PGreen2 x QGreen1)(PRed1 x QRed1) + (PGreen1 x QGreen1) = 2
Numerical Questions and Solutions for Practice
2) Suppose that the Nominal and Real GDP for country Z 2) Suppose that the Nominal and Real GDP for country Z in 1998 were $8,798.1 (in billion) and $8,536, in 1998 were $8,798.1 (in billion) and $8,536, respectively. While for 1999, the figures were $9,295.4 respectively. While for 1999, the figures were $9,295.4 and $8,897.7. and $8,897.7. a)a)Calculate the implicit GDP deflator for 1998 and 1999Calculate the implicit GDP deflator for 1998 and 1999b)b)Calculate the Inflation rate Calculate the Inflation rate (Calculated as the ratio of (Calculated as the ratio of differences in GDP Deflator with the GDP in base Year)differences in GDP Deflator with the GDP in base Year). . (Related to Mankiw. Pg. 41. Q. 6)(Related to Mankiw. Pg. 41. Q. 6)
Solutions for Q.2: hint
Deflator in Year 1998 =NGDP 1998RGDP 1998
----------------------------
=8798.18536.0
-------------------
= 1.0307
Deflator in Year 1999 =NGDP 1999RGDP 1999
----------------------------
=9295.48897.7
-------------------
= 1.0447
Now Calculate Inflations rate yourself
Thank You